Appendix B. Home Ownership and Equity Protection Act

The following is an excerpt from the Federal Reserve explaining the reason for the Home Ownership and Equity Protection Act (HOEPA) and some of its provisions. This will give you a general understanding of the problems associated with unfair mortgage loan practices and what the government is doing to mitigate them.

Should you wish to contact the board, you can call the Federal Reserve Consumer Help phone number at 888-851-1920.

I. Background

Since the mid-1990s, the subprime mortgage market has grown substantially, providing access to credit to borrowers with less-than- perfect credit histories and to other borrowers who are not served by prime lenders.

With this increase in subprime lending, there has also been an increase in reports of predatory lending. The term predatory lending encompasses a variety of practices. In general, the term is used to refer to abusive lending practices involving fraud, deception, or unfairness. Some abusive practices are clearly unlawful, but others involve loan terms that are legitimate in many instances and abusive in others, and thus, are difficult to regulate.

Loan terms that may benefit some borrowers, such as balloon payments, may harm other borrowers — particularly if they are not

fully aware of the consequences. The reports of predatory lending have generally included one or more of the following:

• making unaffordable loans based on the borrower's home equity without regard to the borrower's ability to repay the obligation;

• inducing a borrower to refinance a loan repeatedly, even though the refinancing may not be in the borrower's interest, and charging high points and fees each time the loan is refinanced, which decreases the consumer's equity in the home; and,

• engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower. For example, packing loans with credit insurance without a consumer's consent.

A. The Home Ownership and Equity Protection Act

In response to anecdotal evidence about abusive practices involving home-secured loans with high rates or high fees, in 1994 Congress enacted the Home Ownership and Equity Protection Act (HOEPA), Pub. L. 103-325, 108 Stat. 2160, as an amendment to the Truth in Lending Act (TILA), 15 U.S.C. 1601 et seq . TILA is intended to promote the informed use of consumer credit by requiring disclosures about its terms and cost. TILA requires creditors to disclose the cost of credit as a dollar amount (the finance charge) and as an annual percentage rate (APR). Uniformity in creditors' disclosures is intended to assist consumers in comparison shopping. TILA requires additional disclosures for loans secured by a consumer's home and permits consumers to rescind certain transactions that involve their principal dwelling. TILA is implemented by the

Board's Regulation Z, 12 CFR part 226. The HOEPA identifies a class of high-cost mortgage loans through rate and fee triggers, and it provides consumers entering into these transactions with special protections. The HOEPA applies to closed-end, home equity loans (excluding home-purchase loans) bearing rates or fees above a specified percentage or amount. A loan is covered by the HOEPA if (1) the APR exceeds the rate for Treasury securities with a comparable maturity by more than ten percentage points or (2) the points and fees paid by the consumer exceed the greater of 8% of the loan amount or $400. The $400 figure set in 1994 is adjusted annually based on the Consumer Price Index. The HOEPA is implemented in Sec. 226.32 of the Board's Regulation Z.

The HOEPA also amended TILA to require additional disclosures for reverse mortgages that are contained in Sec. 226.33 of Regulation Z. For purposes of this notice of rulemaking, however, the term HOEPA-covered loan (or HOEPA loan) refers only to mortgages covered by Sec. 226.32 that meet the HOEPA's rate or fee-based triggers. Creditors offering HOEPA-covered loans must give consumers an abbreviated disclosure statement at least three business days before the loan is closed, in addition to the disclosures generally required by TILA before or at closing. The HOEPA disclosure informs consumers that they are not obligated to complete the transaction and could lose their home if they take the loan and fail to make payments. It includes a few key items of cost information, including the APR. In loans where consumers have three business days after closing to rescind the loan, the HOEPA disclosure thus affords consumers a minimum of six business days to consider accepting key loan terms before receiving the loan proceeds. The HOEPA restricts certain loan terms for high-cost loans because they are associated with abusive lending practices. These terms include short-term balloon notes, prepayment penalties, nonamortizing payment schedules, and higher interest rates upon default. Creditors are prohibited from engaging in a pattern or practice of making HOEPA loans based on the homeowner's equity without regard to the borrower's ability to repay the loan. Under the HOEPA, assignees are generally subject to all claims and defenses with respect to a HOEPA loan that a consumer could assert against the creditor. The HOEPA also authorizes the Board to prohibit acts or practices in connection with mortgage lending under defined criteria.

Section 1602 (a)

(1) A mortgage referred to in this subsection means a consumer credit transaction that is secured by the consumer's principal dwelling, other than a residential mortgage transaction, a reverse mortgage transaction, or a transaction under an open end credit plan, if —

(A) the annual percentage rate at consummation of the transaction will exceed by more than ten percentage points the yield on Treasury securities having comparable periods of maturity on the fifteenth day of the month immediately preceding the month in which the application for the extension of credit is received by the creditor; or,

(B) the total points and fees payable by the consumer at or before closing will exceed the greater of —

(i) 8% of the total loan amount; or,

(ii) $400.

(a) Disclosures

(1) Specific disclosures

In addition to other disclosures required under this subchapter, for each mortgage referred to in section 1602 (aa) of this title, the creditor shall provide the following disclosures in conspicuous type size:

(A) "You are not required to complete this agreement merely because you have received these disclosures or have signed a loan application.''

(B) "If you obtain this loan, the lender will have a mortgage on your home. You could lose your home, and any money you have put into it, if you do not meet your obligations under the loan."

(2) Annual percentage rate

In addition to the disclosures required under paragraph (1), the creditor shall disclose —

(A) in the case of a credit transaction with a fixed rate of interest, the annual percentage rate and the amount of the regular monthly payment; or,

(B) in the case of any other credit transaction, the annual percentage rate of the loan, the amount of the regular monthly payment, a statement that the interest rate and monthly payment may increase, and the amount of the maximum monthly payment, based on the maximum interest rate allowed pursuant to section 3806 of title 12.

(b) Time of disclosures

(1) In general

The disclosures required by this section shall be given not less than three business days prior to consummation of the transaction.

(2) New disclosures required

(A) In general

After providing the disclosures required by this section, a creditor may not change the terms of the extension of credit if such changes make the disclosures inaccurate, unless new disclosures are provided that meet the requirements of this section.

(B) Telephone disclosure

A creditor may provide new disclosures pursuant to subparagraph (A) by telephone, if —

(i) the change is initiated by the consumer;


(ii) at the consummation of the transaction under which the credit is extended —

(I) the creditor provides to the consumer the new disclosures, in writing; and,

(II) the creditor and consumer certify in writing that the new disclosures were provided by telephone, by not later than three days prior to the date of consummation of the transaction.

(3) Modifications

The Board may, if it finds that such action is necessary to permit homeowners to meet bona fide personal financial emergencies, prescribe regulations authorizing the modification or waiver of rights created under this subsection, to the extent and under the circumstances set forth in those regulations.

(c) No prepayment penalty (1) In general

(A) Limitation on terms

A mortgage referred to in section 1602 (aa) of this title may not contain terms under which a consumer must pay a prepayment penalty for paying all or part of the principal before the date on which the principal is due.

(B) Construction

For purposes of this subsection, any method of computing a refund of unearned scheduled interest is a prepayment penalty if it is less favorable to the consumer than the actuarial method (as that term is defined in section 1615

(d) of this title).

(2) Exception

Notwithstanding paragraph (1), a mortgage referred to in section 1602 (aa) of this title may contain a prepayment penalty (including terms calculating a refund by a method that is not prohibited under section 1615 (b) of this title for the transaction in question) if —

(A) at the time the mortgage is consummated —

(i) the consumer is not liable for an amount of monthly indebtedness payments (including the amount of credit extended or to be extended under the transaction) that is greater than 50% of the monthly gross income of the consumer; and,

(ii) the income and expenses of the consumer are verified by a financial statement signed by the consumer, by a credit report, and in the case of employment income, by payment records or by verification from the employer of the consumer (which verification may be in the form of a copy of a pay stub or other payment record supplied by the consumer] —

(B) the penalty applies only to a prepayment made with amounts obtained by the consumer by means other than a refinancing by the creditor under the mortgage, or an affiliate of that creditor;

(C) the penalty does not apply after the end of the five-year period beginning on the date on which the mortgage is consummated; and,

(D) the penalty is not prohibited under other applicable law.

(d) Limitations after default

A mortgage referred to in section 1602 (aa) of this title may not provide for an interest rate applicable after default that is higher than the interest rate that applies before default. If the date of maturity of a mortgage referred to in subsection [1] 1602(aa) of this title is accelerated due to default and the consumer is entitled to a rebate of interest, that rebate shall be computed by any method that is not less favorable than the actuarial method (as that term is defined in section 1615 (d) of this title).

(e) No balloon payments

A mortgage referred to in section 1602 (aa) of this title having a term of less than five years may not include terms under which the aggregate amount of the regular periodic payments would not fully amortize the outstanding principal balance.

(f) No negative amortization

A mortgage referred to in section 1602 (aa) of this title may not include terms under which the outstanding principal balance will increase at any time over the course of the loan because the regular periodic payments do not cover the full amount of interest due.

(g) No prepaid payments

A mortgage referred to in section 1602 (aa) of this title may not include terms under which more than two periodic payments required under the loan are consolidated and paid in advance from the loan proceeds provided to the consumer.

(h) Prohibition on extending credit without regard to payment ability of consumer

A creditor shall not engage in a pattern or practice of extending credit to consumers under mortgages referred to in section 1602 (aa) of this title based on the consumers' collateral without regard to the consumers' repayment ability, including the consumers' current and expected income, current obligations, and employment.

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